Navigating the Complexities of Business Overvaluation: A Comprehensive Guide

29.11.23 07:06 PM Comment(s) By ingmarbooijandpartners

Introduction

In my extensive career as a private investor and business acquirer, I have encountered a recurring and significant challenge: the overvaluation of businesses on sale. Observing this trend in about 95% of all listings on business sale platforms, I've come to recognize the need for a deeper understanding and rational approach towards business valuation. This guide aims to unravel the intricacies of overvaluation, drawing on my experience to offer pragmatic insights to sellers aiming for successful transactions.

Understanding Overvaluation

Overvaluation in business sales arises when the asking price significantly overshoots the market value. While normal valuations for small businesses typically lie between 2.2 and 2.6 times EBITDA, recent trends have alarmingly shown sellers demanding as much as 8, 32, or even 50 times EBITDA. Such expectations are not just unrealistic but also disconnected from market realities. This disparity often results from emotional attachment and an overestimation of future potential, leading to an inflated price that doesn't align with tangible factors like financial performance, profitability, and growth potential.

A recent example was a seller that wanted a certain price, because that would cover his outstanding mortgage on his home. While understandable, it was completely unrelated to teh actual value of his business.

The Buyer's Dilemma with Overvalued Businesses

As a buyer, navigating through overvalued listings is a daunting task. It's not just the price that's at stake; it's the entire understanding and approach towards valuing a business. Encountering a business priced at, say, 50 times EBITDA immediately signals impractical expectations, often resulting in protracted negotiations or even deal abandonment. This is especially frustrating when other investment avenues, such as the stock market, offer more attractive and less risky opportunities.

Bridging the Valuation Gap

To address this valuation gap, it's imperative for sellers to obtain professional valuations and comprehend current market trends. This helps in setting a realistic price that aligns with what buyers are willing to pay. Additionally, understanding the rationale behind a buyer's valuation can lead to more effective negotiations and successful sales.

You can get a free valuation by an independt party here.

Consequences of Overvaluation

The repercussions of overvaluation extend beyond just a prolonged time on the market. An overvalued business can suffer from a tainted market perception, reduced buyer interest, and vulnerability to undervalued offers. This is counterproductive for sellers who have dedicated significant effort into their business.

Worse, in many cases sellers have to stay in their business while they do not want to for years because no one will buy their business for inflated prices. Make up you mind: freedom or riches.

Hint: the riches are in your mind and will never hit your bank account.

Navigating Overvaluation as a Buyer

When faced with overvalued businesses, my strategy involves thorough due diligence and informed negotiation. If the valuation far exceeds industry standards without substantial justification, alternative investment options become more appealing. As a buyer, it's crucial to weigh the risks and potential returns, and sometimes that means looking beyond overvalued listings to more viable opportunities.

Seller's Advice: Be Reasonable and Creative

To sellers, I offer this advice: be reasonable in your valuation expectations. Consider whether you would wait decades to recoup your investment – as expecting a buyer to accept a valuation of 8, 32, or 50 times EBITDA is akin to asking them to do just that. Instead, focus on the structure of the deal. Consider seller financing, which can offer interest income – an appealing prospect for retirees (this can often be secured by way of buyer having to return the shares if they do not meet payments). Retaining a minority stake in your business could also lead to future gains (earn outs often lead to discussions and are not tax effecient). These alternative deal structures can more effectively meet your needs, whether it's securing a steady income, reducing immediate workload, or ensuring a future stake in the business's success.

Note to retirees: expecting a buyer to fund your entire retirement in cash, especially if you intend to walk away from the business entirely, is often unrealistic. A more balanced approach, incorporating elements like seller financing or retaining a minority interest, can provide ongoing benefits while making the deal more attractive to buyers.

Conclusion

Overvaluation in business sales is a multifaceted issue that demands a balanced approach from both sellers and buyers. Sellers need to align their expectations with market realities, and buyers must approach each opportunity with thorough research and clear investment criteria. By doing so, the business sale process becomes more transparent, fair, and conducive to successful outcomes for both parties.

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